Petrodollar and Crypto Series #1 of 3: Here’s How to Use the Petrodollar Playbook to Understand Cryptocurrency Pricing

Fiat currencies, central banks, and monetary policy. All things crypto enthusiasts love to hate, right?

Well, just because you don’t like fiat money issuers’ policies doesn’t mean you can’t learn a thing or two from their playbook.

Fiat currency “projects” have some important parallels with good crypto projects that are worth considering especially if you want to understand the fundamentals — not the speculation — behind cryptocurrency prices.

In this article, we’re going to explain why and use the petrodollar system as an example of a fiat currency success story. Ethically or morally successful? Probably not. But you can’t argue that it worked.

The petrodollar system basically involves the United States dollar being politically installed into the middle of a critical global industry.

For a deeper dive into the history behind the petrodollar, here is an excellent starting place.

But just to summarize, the United States dollar used to be backed by gold, meaning that you could trade in your dollars for a certain amount of gold. Therefore there was healthy demand for dollars around the world because everyone — including other governments — wanted to use dollars to do business. The dollars would not lose value because they were backed by gold.

Then towards the end of the 1960’s, the United States government was overspending on various things including a war in Vietnam. Everyone knew it and (correctly) predicted that the United States would not be able to keep paying out gold for dollars forever. So they started trading their dollars for gold while they still could. As expected, the United States stopped paying out gold for dollars in 1971.

But the United States government wanted to give people a reason to keep using dollars even though they weren’t backed by gold anymore. So the US government made a deal with Saudi Arabia in 1974.To receive American military protection, all the Saudis had to do was sell their oil exclusively for dollars. Anyone who wanted to buy oil from Saudi Arabia therefore needed dollars to do so. And by the end of 1975, every OPEC oil producer had made a similar deal with the United States government.

Voila! Tremendous global demand for oil now meant tremendous global demand for dollars to buy it. Ultimately, all of that is why the United States dollar became the world’s so-called reserve currency, i.e. the best currency for storing value. Except now it was backed by demand for oil instead of gold.

The story doesn’t end there. Being in charge of the world’s reserve currency gave the United States Federal Reserve an excuse to print plenty of money. It is a questionable economic strategy that any crypto enthusiast is likely to argue against.

But what we’re highlighting here is how effective the petrodollar plan was. As an act of evil genius, if you will.

Previously we discussed the importance of effective execution around well-defined use cases for cryptocurrencies, and the same is true of fiat currencies. For the petrodollar, the use case was to be a medium of exchange for a critical — arguably the most critical — global industry. And US Secretary of State Henry Kissinger executed to bargain superpower military protection in exchange for locking in this use case.

The lesson here is that if your currency is not backed by a traditionally valuable physical asset like gold, then your goal should be to position it between strong supply and demand for something.

In other words, if you want a unbacked currency — fiat or crypto — to be stable and have real value, you want to put it at the heart of a strong market.

Now let’s take that lesson and apply it to pricing in the cryptosphere.

We think the best non-speculative way to predict a cryptocurrency’s price is how well it serves as a “hard coded mini petrodollar for X.”

The petrodollar system is all about thinking BIG. It is the result of a grand bargain between the country with the most powerful military force at the time and a group of countries controlling one of the world’s most critical industries.

The concept has so many massive moving parts, in fact, that you don’t see many — if any — attempts to replicate the petrodollar in other industries. There is no “ferroruble” system for iron ore produced in Australia and priced in Russian rubles, for example. The goal is so big as to be out of reach of most world governments.

In the cryptosphere, however, a relatively small but talented development team can create a currency hard coded as an exclusive medium of exchange in a market with no geographical borders. In fact you’ll find that basic concept is in almost every initial coin offering whitepaper! Execution is always an issue — but doesn’t take anywhere near the resources or bargaining power of a superpower military.

And for a cryptocurrency to achieve respectable value it doesn’t necessarily have to be hard coded into a market as massive as the one for oil. In fact the market can be relatively small.

That’s because instead of pressure to prop up their currency’s value immediately and artificially through a political deal, cryptocurrency stakeholders (developers, miners, and users) have the flexibility to allow their currency’s value to grow gradually and organically as more people participate in the market.

Today, therefore, the best way to predict the price of a given cryptocurrency is to think about how well it serves as a “hard coded mini petrodollar for X.” Such a cryptocurrency is installed — technically, not politically — into a relatively smaller market with no geographical borders. This market could be for just about anything, maybe even a sub-market of a larger industry. The strength of that market will determine the strength of the cryptocurrency.

Two closing thoughts here:

First, we aren’t getting into speculation or technical chart-based trading strategies here. Obviously, speculators and traders can and do make fortunes predicting the prices of currencies, fiat or crypto.

But we like to think of crypto projects in terms of real use cases. We’ve touched on that before. Therefore we believe that the petrodollar-style thinking is more effective when it comes to predicting prices and thinking about the crypto space in general.

And in our opinion, speculation and trading wasn’t a key element of the petrodollar plan to prop up the value of the US dollar. In fact it was just the opposite. The whole thing was designed to fight the speculative downward pressure on US dollar prices, i.e. investors selling off their US dollars for gold. The US government didn’t want to leave it up to speculative chance that the US dollar would be the world’s reserve currency. They stepped in and did something about it — and we can debate their ethical and political reasons for doing so.

Second, a cryptocurrency can also be what we would consider a “de facto mini petrodollar for X.”

Think about how “privacycoins” or “stablecoins” supposedly work. Certain coins — usually but not always because of certain technical features — are attractive to use for a certain purpose. They gain popularity for “X” primarily due to the network effect, i.e. because everyone is using them to do “X.”

To what extent everyone chooses to use a cryptocurrency to do something is a reasonable metric for predicting its price. We just don’t think it is the best one.

Imagine, for example, if the US government in 1974 had decided that they were going to balance the national budget and strengthen the American economy so as to inspire confidence in the dollar. That way, buyers and sellers of oil would choose to use the dollar as their medium of exchange. Or not, depending on their judgment.

That didn’t happen. But philosophically it sounds pretty good. That’s basically the same thinking behind the different privacycoins, for example. The project teams behind Monero and Zcash work to incorporate the best privacy features they can into the cryptocurrencies, and users choose which they prefer for their transactions requiring privacy.

If you were going to predict the prices of Monero vs Zcash, however, you wouldn’t just have to have your own opinion about the technical features behind the coins. You’d also have to predict how other people would view those technical features. And how well the network effects would work regardless of those technical features. Remember that not everyone using cryptocurrencies actually knows or cares about the technicalities behind them.

With a cryptocurrency hard coded into a market, you basically just need to predict how strong the market will be, and the cryptocurrency’s price will necessarily reflect it. A far simpler and robust approach, in our opinion!

So that’s the theory. For a practical example of how to put into action, check back next week to see how we apply it to the BST, the BlockStamp’s native cryto coin.

About BlockStamp:

BlockStamp is a multipurpose Bitcoin blockchain fork developed by the BlockStamp Foundation, a not-for-profit organization. Designed to promote liberty, transparency, and sovereignty in areas of the digital economy where these fundamental values are most at risk, BlockStamp hosts a radically fair gambling platform, a digital tool for transparently sealing data, and a censorship-proof internet Domain Naming System.